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Pension Pressure

Antony Barker, Santander’s pensions director, explores the impact on banks’ stability and solvency measures posed by their pension risks

Defined benefit pension schemes can be measured in three ways – the triennial actuarial valuation of ongoing funding, IAS 19 accounting disclosures, or the cost of buying out all the liabilities with an insurance company. Each test compares the market value of assets held with a calculation of the present value of future pension pay-outs. What differentiates the tests is the choice of discount rate – referencing either a long-dated gilt or high-quality corporate bond of similar duration to the total liabilities – irrespective of how the scheme’s investments are actually invested. Given pensions may be payable for 70 years or more (who knows how much more life expectancy will improve?) and no such bonds exist, then the liability valuation is subjective. Add in the volatility of the equity and real estate markets that pension schemes actually invest in and it’s clear that even the triennial actuarial valuation can produce variation in results.

Whichever measure you choose, it’s generally agreed that pension scheme funding levels have deteriorated significantly in recent years, driven by the fall of long-term interest rates exacerbated by the Bank of England’s loosening monetary policies. As a result, managing the risk arising from a bank’s pension arrangements has become the main non-core financial risk for banks due to its direct impact on their Common Equity Tier 1 ratio.